CFAI Vol. II, Reading 22, EOC 4 (and) 5 (pg 486/487) decrease, therefore, related, correct, thread

b_sea93

Hi all,
Only found a thread related to EOC #6. Was hoping for some help with the CFAI answer.
4. A is correct. Decreasing equity holdings will lower risk associated with the pension plan assets. If operating risks remain the same, total asset risk will decrease from 0.364 to 0.32. Pension assets’ beta now becomes 0.6, and the OPERATING ASSETS BETA REMAINS AT 0.087, therefore total risk beta = 0.087 x $17 / $31 + 0.6 x $14/ $31 = 0.32.
Why does the operating asset beta remain the same?
1) Originally (no pension assets), total asset beta = operating asset beta = 0.6635.
2) Then we brought in pension assets, and say that total asset beta decreases to 0.3639 and operating asset beta (by back calculation) is only 0.087. – * Change in assets, change in beta *
3) Now all of a sudden we change the assets (pension beta 0.7 to 0.6) and they are saying the operating asset beta is constant?
Any help you could provide would be appreciated. I just assumed you would calculate it all the same way as in question 3, except with 0.6 pension asset beta vs. 0.7.

John10

The idea is that operating assets stay the same.
It is implied that because of efficient markets the total beta of the firm is correctly estimated based on the pension assets. Changing the pension asset beta does not change the operating assets beta but will affect the equity beta.
Either issue more debt if you have more debt in pension or issue more equity if you add more equity.

willsucceed

One bump only. Thanks!